EU-zone inflation may drop to 0.2% in May

LONDON - Euro zone inflation is forecast to have dropped to a new record low in May, dragged down by lower energy and food prices, preliminary data are expected to show next Friday.

A Reuters poll of 37 economists showed inflation probably sank to just 0.2 percent this month, considerably lower than the 0.6 percent seen in April, and way below the European Central Bank's 2 percent target ceiling.

Even though oil prices have started to rise again, the bull market in the first half of 2008 means that a year-on-year comparison is becoming more negative with every month that passes, said Ralph Solveen at Commerzbank.

A favourable base effect will have brought the rate down as at this time last year energy prices were surging so inflation may yet have further to fall.

A separate Reuters poll earlier this month saw inflation averaging -0.1 percent in the third quarter of the year.

Forecasts for May ranged from 0.0 to 0.4 percent so fears of imminent deflation, a widespread and sustained fall in prices, do not seem to have much hold. Inflation is forecast to pick up again towards the end of the year and into 2010.

Given the growing excess capacity in the euro zone an actual negative year-on-year reading cannot be ruled out in the next few months, said ING in a research note.

Falling inflation will support the ECB's decision to slash interest rates to just 1.0 percent at the start of May and its plans to buy up to 60 billion euros of covered bonds in an effort to boost an economy in the throes of a deep recession.

The euro zone economy shrank 2.5 percent in the first quarter, its deepest contraction on record, but data released on Thursday showed the rate of contraction had eased in both the manufacturing and dominant services sectors.